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Angel Financing vs Venture Capital vs Crowdfunding

Sometimes, you’ve got an excellent startup business idea but lack financial resources to turn an idea into practice. Traditionally, entrepreneurs have approached Banks or friends and family to help them in starting up the business.  However, there are better & efficient ways of securing funding.

So, in this article, let us review the 3 most popular options for funding startup business i.e. Angel Financing Vs Venture Capital Investment Vs Crowdfunding.

Angel financing

Angel investors (Angels) are generally highly successful business people with high net-worth who use their own money to fund companies & startups. Angels not only provide funding to the business at the initial stages when there is no revenue but also provide guidance to the business. The expectation for return is higher because of more risk than traditional investors & Angels require a ownership stake in the company. Some entrepreneurs often prefer this type of funding as they get sufficient funding to initiate business cash flows with no immediate pressure to provide returns.

Here are some of the factors angel investors look for in a startup.

  • Competence, experience, commitment, passion, and business acumen of the startup founders.
  • Market feasibility of the business idea to assess if there is a demand for the product being manufactured.
  • Comprehensive and relevant business plan to assess the potential of the overall business idea.
  • Development of intellectual/technological assets with their investment.
  • Appropriate business valuation developed with realistic assumptions.
  • Viability of the startup to raise additional funds after some progress.

Fast facts about the angel investors

  • Angel investors are mainly attracted to investment opportunities with defined exit strategies as there is a significant risk.
  • These investors are called angels because they help the startups when they have nothing, and no commercial banks seem to approve the loan.
  • Angel investing has been one of the primary sources of finance in the last few decades and helped in the economy’s growth.
  • These investors look for helping a startup to grow as their priority is not immediate returns.

A few Famous Angel Investors (Shark Tank TV personalities) listed below.

  • Mark Cuban
  • Lori Greiner
  • Robert Herjavec
  • Daymond John
  • Kevin O’Leary 

Venture capitalist – VC

These are the investors that provide capital to firms with higher growth potential. In return, they demand a certain equity stake in the company/startup. Usually, some partners combine their funds and start investing in small companies/startups to get a return on their investment.

To form a VC structure, the money is pooled by wealthy individuals, insurance companies, pension funds, foundations, etc. These investors combine their funds and hand them over to the venture capital firm for effective management and return. A venture capitalist firm is a general partner and charge management fee from the investors.

These VCs firms usually do not look for the startup business but the businesses at the stage to commercialize their business idea. So, there are higher chances of funding approval if your startup is expected to generate cash in a very short time. Further, the most important investment criteria for the VC is a great management team; they are interested to know if the business has the right set of skills, experience, drive, managing capability, temperament, and growth attitude to ensure the multiplication of their wealth. They are specifically concerned about managing the competence of the strategic core to assess if they have a certain vision and strong managing policy.

Since VC firms are professional investing organizations, they are expected to have higher competence and strong understanding of the investment matters. Hence, you are required to be able to explain how they manage the business risk in terms of operational and financial aspects.

So, you must be able to adequately explain risk management in terms of principal risk, legal risk, regulatory risk, product liability risk, and other areas of business management like data protection and effective financial and operational controls.

In general, here is what venture capitalists are looking for in the investment opportunity.

  • Opportunities with massive potential for growth and return.
  • Businesses with a unique product, greater market size, and strong competitive capabilities to support their motive of getting a higher return.
  • VCs look for companies with the first-mover advantage (it enables VCs to get a higher return on their investment).
  • The business with a competitive edge that may be in terms of product differentiation, process differentiation, super niche differentiation, price point differentiation, etc.
  • Strong management team to ensure they can handle aggressive growth in the process.
  • An excellent presentation for persuading VC that how their investing motives are met by investing in your business.
  • Comprehensive plan to explain how the money from VC will be used in the business.

Fast facts about the venture capitalist

  • There is a partnership behind the investment made by VC.
  • They are looking for an investment with a higher return.
  • They are interested in the company’s leadership and risk management policies.
  • They are attracted towards companies with strong internal capability/competence to get a long term success.
  • They need to understand how the company intends to use their money.

You can find list of VC firms on Wikipedia page.

Crowdfunding

It’s a form of financing from the large portfolio of investors generally on the internet. The concept has revolutionized the finance industry and is expected to massively contribute to the business economy. The beauty of crowdfunding is the large customer base that makes it possible for the startup to raise quick financing.

Detailed concept

Raising finance through traditional financing arrangements like angel investors/venture capitalists can be a complex and more time-consuming. Further, it’s often difficult to find an investor to raise funds. Crowdfunding can be made up of a small investment made by a large number of investors. Hence, there is a low risk in terms of the amount invested.

Crowdfunding platforms are open for entrepreneurs to present their business in front of the large investor pool. However, you need to ensure that the business idea is presented in a persuasive and professional tone to attract maximum investors.

Pros & Cons of Crowdfunding.

Pros:

  • Lower procedural formalities for the business intend to raise the finance. Although, there are requirements for the registration with crowdfunding platform.
  • A large base of investors can be accessed with the business startup. Further, it’s a great way to interact with the consumer base.
  • Entrepreneurs get public opinion on their business idea as if investors accept there are higher chances of the startup success.

Cons:

  • Usually, if you do not meet the funding goal, any finance raised may be returned to the investors.
  • A certain fee is payable to the crowdfunding platforms. So, you have to incur some costs.
  • If your ideal is not accepted or you cannot raise the finance via a platform, it might damage the reputation of your startup.

It’s important to note that crowdfunding can be in the following two forms from an investor perspective.

  • Donation-based funding (the startup does not have to pay back/no equity stake is given).
  • Reward-based funding (the startup has to give away a certain equity stake).

Fast facts about the crowdfunding

  • The global crowdfunding market is expected to reach $114 billion by 2021.
  • On average, 22.9% of the crowdfunding operations get success.
  • The use of social media can be an excellent tool for reaching potential investors.
  • Most platforms follow all or nothing funding model. (It means if the startup fails to achieve their financing goals, any finance raised will be returned to the investors).
  • Investors have the choice to split investment between large number of businesses, thereby reducing risk.

Some of the prominent crowdfunding sites are listed below.

www.seedinvest.com

www.gofundme.com

www.ourcrowd.com

Frequently asked questions

What are the advantages of raising finance through angel investors?

The main beauty of angel investors is that funds received from them do not need to be paid in cash. Instead, they are an owner in your business idea, and they only earn when you earn.

So, if you’ve raised finance through angel investors, you don’t need to consider repayment in your financial planning.

What is the disadvantage of raising finance through angel investors?

The main disadvantage of raising through angel investors is that you’ve to give away a certain ownership stake. Further, there may be some concerns regarding controls if your investor wants to pr0actively manage business operations.

Do venture capitalists fail?

Yes, they presume a higher level of risk for the higher return. They do fail. Their chances of failure are higher because they are always looking for a higher return.

Why is crowdfunding becoming so popular?

Following are some of the reasons for the massive acceptance of crowdfunding platforms.

  • A large pool of investors is available on the internet.
  • Reach to the potential investor is comparatively easy.
  • It helps to assess the potential of your business idea.
  • The process is highly efficient.

What risks are associated with the process of crowdfunding?

  • There is a higher risk of default as there is a higher rate of startup failure.
  • There is a higher risk of default due to the online nature of the arrangement.
  • There is an institutional risk, as platform closing will leave no data and contracts etc.
  • The investor may not be able to sell their stake. Hence, there is frictional liquidity.
  • The investors do not get any collateral, and it’s an inherent risk brought by this arrangement.
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